Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Tracy Alloway and I'm Jill Wisenthal Joe dedollarization. There's
Speaker 1: a lot of annoying stuff in there.
Speaker 2: Yeah, we're still talking about that.
Speaker 3: No, it is.
Speaker 2: It's interesting because, yes, it's like this sort of I
Speaker 2: don't know, I associated with cranks and stuff. But if
Speaker 2: you actually take the subject seriously about why the dollar
Speaker 2: is what it is and where it is, there's many
Speaker 2: sort of illuminating sub conversations to be had.
Speaker 1: Yes, so it is a theme that tends to be
Speaker 1: dominated by a certain type of person. But setting that aside,
Speaker 1: one thing that's good about it is it actually gives
Speaker 1: us a peg to go back and look in depth
Speaker 1: at the financial system and ask, well, why is it
Speaker 1: designed this way? Why is it built this way? Why
Speaker 1: did dollars become popular as FX reserves in the first place,
Speaker 1: And beyond that, why do we seem to have all
Speaker 1: these different types of dollars. So we have euro dollars,
Speaker 1: which hopefully everyone has heard of before, we have petro dollars.
Speaker 1: There are all these different flavors of dollars floating around
Speaker 1: the financial system.
Speaker 2: Right, there's two interesting points you made. One is like
Speaker 2: this conversation allows us to go back and look at
Speaker 2: things like, well, why are things the way they are?
Speaker 2: Which is helpful. And you know, a recent episode we
Speaker 2: did with Karthik Sound Ground was good on that. And
Speaker 2: then to your point, though, like, there is no single
Speaker 2: thing the dollar, right, and maybe if someone thinks the dollar,
Speaker 2: the first thing they think about is a dollar in
Speaker 2: their digital bank account or a dollar bill, But there
Speaker 2: is no single thing that's the dollars. A bunch of
Speaker 2: things that are basically pegged against each other and like
Speaker 2: are usually roughly stable against each other.
Speaker 1: That's absolutely right. It's also one of the reasons I
Speaker 1: tend not to like talking about currencies that much, as
Speaker 1: everything ends up being relative. But setting that aside, I
Speaker 1: do enjoy talking about the history of the financial system
Speaker 1: and the decisions that made it the way it is today.
Speaker 1: And so I'm very pleased to say that we have
Speaker 1: one of our favorite All Thoughts guests back with us,
Speaker 1: someone who is going to be taking us down the
Speaker 1: historical path of how we ended up with things like
Speaker 1: euro dollars and petro dollars.
Speaker 2: I'm very excited about this episode as well. I like
Speaker 2: history lessons as well. And you know, all of these
Speaker 2: things and have surprising origins, and they emerge organically, which
Speaker 2: is part of what makes them hard to you know,
Speaker 2: when eventually things change. Maybe one day there'll be a
Speaker 2: you know, a different currency regime in the world. But again,
Speaker 2: it's helpful to know the origins of these things to
Speaker 2: sort of anticipate what that what that might look.
Speaker 1: Like, right, And I think actually there is often an
Speaker 1: assumption that they do emerge organically when actually there is
Speaker 1: a very conscious decision, right that went into making them
Speaker 1: what they are today, and then they sort of evolved
Speaker 1: from there. But without further ado, I'm very happy to
Speaker 1: say that we are going to be speaking with Josh Younger,
Speaker 1: formerly at JP Morgan, now a senior advice at the
Speaker 1: New York Fed. Josh, welcome back to the show.
Speaker 3: Thanks, it's great to beat back.
Speaker 1: So I believe, given your new employer, you have to
Speaker 1: start with a disclaimer, right, well, I have to.
Speaker 3: I guess this is literally something I've always wanted to say,
Speaker 3: which is that these views are my own and do
Speaker 3: not necessarily reflect those of the Federal Reserve Bank of
Speaker 3: New York or the Federal Reserve System.
Speaker 4: This is why.
Speaker 2: Actually, it's always been fun to speak with you, because
Speaker 2: in addition to your various employment over time, you're also
Speaker 2: just a very curious person who discovers new things.
Speaker 3: I try to Yeah, it's fun to dig down. So
Speaker 3: I hope this isn't too much of a rabbit hole,
Speaker 3: but it is a very we.
Speaker 1: Like rabbit holes. Yeah, all right, Well, why don't we
Speaker 1: start at the beginning. You know, I sort of alluded
Speaker 1: to these different flavor of dollars, and I think we're
Speaker 1: going to be focusing on two of them. They are
Speaker 1: euro dollars, so US dollar denominated deposits at foreign banks.
Speaker 1: People sometimes look at them as like a liquidity measure.
Speaker 1: How many euro dollars are slashing around in the system
Speaker 1: and what does that actually mean for risk appetite and
Speaker 1: things like that. And petro dollars, which are just dollars
Speaker 1: earned from the export of oil, which tends to be
Speaker 1: denominated in dollars still despite a lot of noises to
Speaker 1: the contrary. But where do we begin with this? Because
Speaker 1: I think euro dollars nowadays I kind of think like, well,
Speaker 1: you know, they've been around for a long time, but
Speaker 1: they must have come from somewhere.
Speaker 3: Yeah, Well, there's a spectrum of dollars. So a dollar
Speaker 3: is a liability, the dollar paper dollars in your pocket
Speaker 3: are a liability of the Federal Reserve system. The dollars
Speaker 3: that your bank issues your liability of that bank. And
Speaker 3: a euro dollar is a dollar denominated liability of a
Speaker 3: non US bank, so something overseas, and that's been around
Speaker 3: for a while. So there were dollar denominated deposits in
Speaker 3: Berlin and Vienna back in the twenties. They're fairly common
Speaker 3: in correspondent banking since then. So correspondent banking is if
Speaker 3: somebody needs to use dollars versus Sey Deutsche Bark's in
Speaker 3: the seventies or the fifties and the forties, they will
Speaker 3: have a bank account locally that has a bank account
Speaker 3: in the US, their bank has a bank account, and
Speaker 3: it's just really a daisy chain back to the US.
Speaker 3: A euro dollar is unique in the sense that it
Speaker 3: is a dollar denominated deposit that has an asset side
Speaker 3: and asset in which it's deployed that is also offshore,
Speaker 3: so it's all disconnected. It's not fully reserved, or in
Speaker 3: other words, it's deployed outside the context of the US
Speaker 3: financial system as well, and in that sense, it's a
Speaker 3: complementary but distinct financial system from the US.
Speaker 1: It's like free range US currency.
Speaker 4: Yeah.
Speaker 3: It kind of reminds me of the beginning of the Internet.
Speaker 3: So the Internet, there's two versions of the Internet. There's
Speaker 3: the Internet and the Cypronet. Everyone talks about how the
Speaker 3: Internet was originally a Defense Department project, and there was
Speaker 3: for a long time. I'm not sure if there still
Speaker 3: is a separate Internet that's an air gap with the
Speaker 3: actual Internet, which is the Cyparnet, which is the secret Internet.
Speaker 2: And so I'm going to go on the secret Internet.
Speaker 3: Yeah, so like UR dollars are not secret, but they
Speaker 3: are separated from the US financial system and in some
Speaker 3: sort of air gap type of way.
Speaker 2: It always seemed like one thing that I have a
Speaker 2: hard time wrapping my head around is, Okay, like banks
Speaker 2: in the US, you know, they have a relationship with
Speaker 2: the Federal Reserve, and if they run into liquidity trouble
Speaker 2: or other kinds of troubles, you know, there's this lender
Speaker 2: of last resort. And then when I think of like, okay,
Speaker 2: here's this other bank maybe somewhere in Europe issuing dollar
Speaker 2: denominated liabilities like other risks associated or when these were born?
Speaker 2: Like how does that? How did this sort of like
Speaker 2: I don't know, I'm struggling to think of the answer,
Speaker 2: but this is like the question, but there's always like
Speaker 2: wrapped from my head around is like what kind of
Speaker 2: risks did these banks issuing dollar denominated deposits in Europe
Speaker 2: face by being outside of the US bankings?
Speaker 3: It's like, what gives how can you do this? Yes,
Speaker 3: you can't just write a dollar.
Speaker 2: Yeah okay, yes, right and expected to be worth it.
Speaker 3: They don't have the relationship, and initially that was basically
Speaker 3: what was done. So the first the definition of the
Speaker 3: ear a dollar being deployed offshore is fairly specific, and
Speaker 3: the question is when did that start? And we don't
Speaker 3: really know. We know roughly in the late forties' declassified
Speaker 3: CII documents after the war ended, the Russians were moving
Speaker 3: money around because they were worried about a subsequent land
Speaker 3: war in Europe and they didn't want their funds to
Speaker 3: be frozen. Never mind the weirdness of like a Soviet
Speaker 3: and Vais where they need dollars. I'm not sure why
Speaker 3: that would be necessary, but they were uncomfortable leaving money
Speaker 3: in New York, and so there were a handful.
Speaker 1: Title of this episode should be the Communist origins of
Speaker 1: euro dollars area.
Speaker 3: Yeah, and so there were a sanctions which connects somewhat
Speaker 3: to today, and they moved their money from New York
Speaker 3: banks to a handful of banks to specifically in France, London,
Speaker 3: and Belgium, because the local regulations allowed those banks to
Speaker 3: issue non local currency deposits. Your local regular has to
Speaker 3: allow this in the first instance. And in Paris in particular,
Speaker 3: there was a bank called basically the Commercial Bank of
Speaker 3: Northern Europe. I'm not going to try to pronounce it
Speaker 3: in French, but it was called BISON. BSM was run
Speaker 3: by a notorious communist sympathizer who had relationships in Moscow,
Speaker 3: and so they were comfortable with that particular bank, and
Speaker 3: they grew its assets from seven million dollars to two
Speaker 3: hundred million dollars over a few years. The first recorded
Speaker 3: use of those euro dollars was possibly, although it's hard
Speaker 3: to say, replacing the salaries of striking French coal miners
Speaker 3: forty eight. So there's some evidence of that, but that's
Speaker 3: not really a euro dollar. In the definition that I
Speaker 3: just described, because it doesn't really have a use because
Speaker 3: I didn't say anything about the asset side of the equation.
Speaker 1: So where did the asset side come from? This is
Speaker 1: just going to be one of those episodes where we
Speaker 1: ask you, like, how did this happen?
Speaker 3: So it was tied basically to trade because trade was
Speaker 3: denominated in dollars, but when it's all Communist dollars, it
Speaker 3: has to be east west trades. So trade crossing the
Speaker 3: Iron Curtain, which was small because both the Russians and
Speaker 3: the Americans were not terribly comfortable with a large volume
Speaker 3: of trade, and the Russians in particular had a policy
Speaker 3: of self reliance, so they said, we don't want to
Speaker 3: need imports from the West to run our economy or
Speaker 3: a society. We don't know how big that was. It
Speaker 3: was actually, as of nineteen forty seven illegal to talk
Speaker 3: about economic data in the Soviet Union. It was a
Speaker 3: law passed that said this is like punishable by some
Speaker 3: extreme measure. So we don't actually know the volume of
Speaker 3: this trade, but there's some evidence that it was there,
Speaker 3: that it was funded in part by like trade finance
Speaker 3: was facilitated by b sent to some extent. It's unclear
Speaker 3: when it started, but it's a very small market. The
Speaker 3: reason why there's no other applications is because at this
Speaker 3: time there's really not a foreign exchange market. All foreign
Speaker 3: exchange rates are pegged and controlled because in the wake
Speaker 3: of the Second World War, there was no tolerance for volatility.
Speaker 3: Of course, so the pound, for example, was like a
Speaker 3: controlled exchange rate, which meant if you were to issue
Speaker 3: dollar deposits, you just had dollar liabilities and some non
Speaker 3: dollar asset. You're warehousing this risk that at some point,
Speaker 3: okag goes away.
Speaker 2: So Okay, to Tracey, what or what next? What creates
Speaker 2: this system in which or I guess, is it the
Speaker 2: sort of introduction or the tolerance of currency flexibility that
Speaker 2: starts to create the sort of asset side of it.
Speaker 3: Yeah, in London specifically, they start to get comfortable with
Speaker 3: liberalizing the foreign exchange using what years are we talking about,
Speaker 3: like nineteen fifty one or so. It's like it's a
Speaker 3: gradual product. There are key moments where regulations change, and
Speaker 3: that's kind of to the initial point that Tracy was raising,
Speaker 3: which is like it evolves organically, but there are key
Speaker 3: decision points that affect the outcome in very important ways.
Speaker 3: And so the first decision point is the London foreign
Speaker 3: exchange market is reopened. I think it was December fifty one,
Speaker 3: but it was roughly around nineteen fifty one, and they
Speaker 3: kept the spot rate control, but they allowed FX forwards,
Speaker 3: which you are in agreement to exchange currency at some
Speaker 3: point in the future. That market was allowed to float,
Speaker 3: so you could start exchanging dollars for sterling on a
Speaker 3: forward basis. That's effectively a loan where you collateralize a
Speaker 3: dollar loan with sterling. We have FX swaps today, and
Speaker 3: that enabled banks in London to accept dollar deposits and
Speaker 3: on the asset side they would buy sterling assets, but
Speaker 3: they would hedge the FX risk, and in that environment,
Speaker 3: the pricing of those forwards was such that that was
Speaker 3: an arbitrage opportunity, was free money to do this. It
Speaker 3: was related to the current account deficit. It was related
Speaker 3: to just the inefficiencies of starting a market after World
Speaker 3: War You would imagine they would be there are lots
Speaker 3: of frictions there, and we don't have computers. It was
Speaker 3: like Joe, you were talking in an earlier episode, you know,
Speaker 3: what did you do without computers? And so for a
Speaker 3: time it was this actually free money for these banks
Speaker 3: to attract dollar deposits, issue the liability, buy something in
Speaker 3: sterling and then hedge the foreign exchange risk. Starting in
Speaker 3: nineteen fifty four, the economist starts occasionally talking about foreign
Speaker 3: money in London. It sounds kind of nefarious.
Speaker 2: But it was when you say the economy the magazine,
Speaker 2: the magazine, not the one economist.
Speaker 1: So that was the first mention or one of the
Speaker 1: earlier mentions, of like currency trading as an industry in London.
Speaker 3: And specifically these dollar deposits. So foreign money in this
Speaker 3: context meant a dollar deposit in a London bank, and
Speaker 3: not the US branch, not the London branch of a
Speaker 3: US bank, r a London based city bank. Midland Bank
Speaker 3: is the most popular at the time, it's one of
Speaker 3: the largest. The bank Evlands starts get a little worried.
Speaker 3: But because in nineteen fifty five this market is doubling
Speaker 3: every three months, WHOA.
Speaker 1: So how does the US feel about that? Because just
Speaker 1: going back to the start of the conversation or one
Speaker 1: of the points that Joe brought up, like it does
Speaker 1: feel a little bit weird instinctively when you start to have,
Speaker 1: you know, one country's currency sort of in control or
Speaker 1: being controlled by a foreign entity, or them building up
Speaker 1: like a sizeable bucket of it.
Speaker 3: Yeah, so they have sort of their view of bolves
Speaker 3: over time. They're initially a little intrigued. So in nineteen
Speaker 3: fifty nine is when they kind of get wind of this.
Speaker 3: It was not obviously known to the broader world that
Speaker 3: this was happening, and so in nineteen fifty nine, the
Speaker 3: New York Fed sends a delegation Allen Holmes and Fred
Speaker 3: Klopstock representing what was then kind of the Market's division
Speaker 3: and the research division, to basically do a fact finding mission,
Speaker 3: and they go to London and Continental Europe. It's like
Speaker 3: the most phenomenal business trip. It's like a month and
Speaker 3: Continental Europe and you can't go anywhere for a day, right,
Speaker 3: you have to go for a while. And so they
Speaker 3: come back and they say, there's this continental dollar market
Speaker 3: is what they call it, because that's the non London
Speaker 3: euro dollar market, and it's growing, and they find it
Speaker 3: intriguing as a way to make the dollar useful off shore,
Speaker 3: and that's the way to get people off shore to
Speaker 3: hold dollars to get the dollar proceeds of their trade
Speaker 3: and then to keep those dollars in financial instruments.
Speaker 1: Is that desirable though? Why do they want that?
Speaker 3: It becomes really increasingly desirable because the old Bretonwood system
Speaker 3: that had been put in place after the war, it's
Speaker 3: at a dollar, I set a dollars a claim on
Speaker 3: the FED or a claim on a commercial bank, but
Speaker 3: in breton Woods it's also claim on gold. So foreign
Speaker 3: official institutions, not anybody, but foreign official institutions can exchange
Speaker 3: their dollars for gold at thirty five dollars ounce. It's
Speaker 3: a specified par rate on the dollar. But there's other
Speaker 3: need for gold other than just monetary reserves, like the
Speaker 3: economies growing. People need gold for other purposes, and so
Speaker 3: gold is trading in London at a little more than
Speaker 3: thirty five dollars, So there's an incentive to sell goods
Speaker 3: to the US, get dollars in exchange for those goods,
Speaker 3: use those dollars to get gold for thirty five dollars ounce,
Speaker 3: and then sell that gold for more than thirty five
Speaker 3: dollars in London. That's an arbitrage profit for foreign central banks.
Speaker 3: It's also a drain on the gold reserves. You know.
Speaker 1: So if you get everyone to keep in dollars rather
Speaker 1: than flipping into gold, then that helps preserve your own
Speaker 1: gold reserve.
Speaker 4: Yeah.
Speaker 3: So now there's a place to park your dollars and
Speaker 3: if it pays a high enough interest rate and your
Speaker 3: dollar issuers were not constrained by regulations that made it
Speaker 3: more expensive and harder to pay high interest rates on
Speaker 3: deposits in the US, So they're unconstrained by regulatory limits
Speaker 3: on what they can pay. That's red Q, that was
Speaker 3: reserve requirements, that was insurance premiums, FDIC, insurance premiums, all
Speaker 3: these things that made it hard for US banks to
Speaker 3: pay a higher rate of interest in London. They're completely
Speaker 3: unconstrained by it, and so they can attract those dollars.
Speaker 3: That means the gold is more likely to stay in
Speaker 3: the US, and that keeps the whole system functioning. It
Speaker 3: isn't entirely effective in the beginning. When the Kennedy administration
Speaker 3: comes in. One of his senior advisors is I think
Speaker 3: he said scared to death in his memoirs. He was
Speaker 3: very worried about this gold drain because he likened it
Speaker 3: to a run on a bank. Basically, you're going back
Speaker 3: to the bank and asking for the hard currency out
Speaker 3: of the bank. In this case, the bank is the
Speaker 3: United States government and the hard currency is the gold.
Speaker 3: And when you run out of gold, the system doesn't
Speaker 3: work anymore. You have monetary collapse. And people will later
Speaker 3: recognize that as one of the precipitate in factors with
Speaker 3: a great depression. So there's this very strong and acute
Speaker 3: concern that collapse of the global monetary system could trigger
Speaker 3: like a great depression type out come.
Speaker 2: Tracy asked you about the concerns from the US, and
Speaker 2: you expressed one of them there, But like, what about
Speaker 2: you mentioned briefly the concerns of the Bank of England
Speaker 2: that this mar that industry that was doubling every three months,
Speaker 2: or the size of this market that is doubling every
Speaker 2: three months. How do these foreign regulators or foreign central
Speaker 2: banks feel about their domestic banks accumulating liabilities in a
Speaker 2: currency they don't control, And you know, you imagine you
Speaker 2: could have a run on those banks, like we can't
Speaker 2: help you because we can't.
Speaker 1: Right, there's no fed backstop or anything like that.
Speaker 3: No, And that's that's the interesting thing is that they
Speaker 3: can pay a high rate of interest, but they should
Speaker 3: because there's no liquidity backstop. So if I go to
Speaker 3: a eurobank they were called, and I say I want dollars,
Speaker 3: like they might have a bank account in the US
Speaker 3: where they can fund withdrawals from, but it's not going
Speaker 3: to be fully reserved, which means I might not get
Speaker 3: my dollars and then there's nowhere to go. And so
Speaker 3: the Bank of England and other central banks are initially
Speaker 3: a little skeptical. They like it because it brings business
Speaker 3: to London. They don't like it because it devalues the
Speaker 3: pound in international finance in London specifically, and also it's
Speaker 3: hard to control. And part of this is just usual
Speaker 3: fact finding. This is something all central banks do to
Speaker 3: this day is just try to figureut what's going on,
Speaker 3: because it's really important to have good intelligence. So you know,
Speaker 3: they're concerned only in that they didn't see it coming
Speaker 3: and they don't have detail. Other than that, the record's
Speaker 3: a little sketchy, but ultimately England is pretty supportive because
Speaker 3: it makes London a very important financial center and that's
Speaker 3: very important to them in these sort of post sterling world.
Speaker 2: I find that interesting Tracy, this idea that what's good
Speaker 2: for London was not necessarily good for the internationalization of
Speaker 2: the pound, and that like is at the same time,
Speaker 2: here's London booming at the cost of the sterling being
Speaker 2: the global currency. But it's interesting how like there is
Speaker 2: not some like sort of one to one relationship between
Speaker 2: the importance of the pound and the importance of the
Speaker 2: city of London.
Speaker 4: No.
Speaker 1: Absolutely, well, okay, so just on this note, I mean,
Speaker 1: I we are all aware that nowadays you have these
Speaker 1: things called dollar swap lines. Were those effectively the backstop
Speaker 1: for this or did someone try to address this question
Speaker 1: of like the riskiness of these dollars outside the US
Speaker 1: financial system, so.
Speaker 3: Like somewhat indirectly, I guess I would say, like the
Speaker 3: first so the swap lines started, I think it's sixty two,
Speaker 3: it might be sixty three. But Charlie Coombs, who's the
Speaker 3: special manager for Foreign Exchange at the Federals their Bank
Speaker 3: of New York, is tasked with setting up arrangements with
Speaker 3: foreign central banks. At the time, the focus was defending
Speaker 3: the dollar. So if the dollar comes into attack, everyone's
Speaker 3: worried about speculative attack. That's kind of like the original
Speaker 3: bond vigilant, right, The foreign exchange vigilantes, and they're worried
Speaker 3: that speculative attack on the dollar would lead to a
Speaker 3: greater run on this sort of like international banking arrangement
Speaker 3: that the US was functioning as. And so he goes
Speaker 3: to England and France and Italy and the Bank for
Speaker 3: the National Settlements in Basel and the Swiss National Bank,
Speaker 3: and he slowly but surely negotiates a bunch of swap
Speaker 3: lines which are designed to be able for the US
Speaker 3: at the time to pull in foreign currency and then
Speaker 3: buy the dollar with those foreign currencies. So it's kind
Speaker 3: of the opposite of how they were used in more
Speaker 3: recent years to lend dollars to the world.
Speaker 1: Oh interesting, I didn't realize that.
Speaker 3: Yeah, And so that's the initial logic. But Bob mccallay
Speaker 3: and Catherine Schenk uncovered this second swap line with the
Speaker 3: BIS set up in nineteen sixty four, which was not
Speaker 3: for Swiss franc but was for any other European currency,
Speaker 3: and it was made with the explicit arrangement that the
Speaker 3: BIS would act as a channel to the Euro dollar
Speaker 3: market if it would needed liquidity. So there's evidence that
Speaker 3: the BIS didn't love this swap line. But they say, oh,
Speaker 3: the FED call this and as to draw it, so
Speaker 3: we'll draw on it. It was sort of acting as
Speaker 3: agent for the FED on behalf of the whole system,
Speaker 3: and it was used primarily at the end of the
Speaker 3: year when there were liquidity pressures due to seasonal effects
Speaker 3: or the usual sort of variations in demand for liquidity
Speaker 3: were smoothed over with this swap line. But it was
Speaker 3: also there and got gradually bigger as a backstop to
Speaker 3: the euro dollar market more generally. But it was ultimately
Speaker 3: not a lender of last resort because it required coordination,
Speaker 3: but it was it was a line. It was like
Speaker 3: a lifeline for the euro dollar market in its early days,
Speaker 3: and that allows it to grow a lot. So, you know,
Speaker 3: we were talking about nineteen sixty it's a roughly two
Speaker 3: billion dollar market. By nineteen sixty four, it's roughly ten
Speaker 3: billion dollar market. By the late sixties, it's you know,
Speaker 3: sixty seventy billion dollar market. So it keeps growing exponentially,
Speaker 3: much faster than the money supply.
Speaker 2: So I mean, you sort of anticipated my next question,
Speaker 2: But I think back then and for a long time,
Speaker 2: and many people still take very sort of like quantitative
Speaker 2: ideas about monetary policy that m two and these various
Speaker 2: measures of money supply are really important policy tools or
Speaker 2: things that we should target, etc. How do monetary policy
Speaker 2: makers feel about something offshore or something that is growing
Speaker 2: the supply of existing dollars in the world.
Speaker 3: It's a trade off. So in the mid sixties, this
Speaker 3: goal drain is accelerating, so the US is forced for
Speaker 3: sort of I don't know if you call that monetary
Speaker 3: policy has to do with the currency, but to maintain
Speaker 3: the stability the international financial system and close the current
Speaker 3: account deficit, which was large. To basically stop the flow
Speaker 3: of dollars out of the country and bring balance to
Speaker 3: the global monetary system, they had to impose capital controls.
Speaker 3: So that starts with what's called the interest equalization tax,
Speaker 3: which was basically penalizing the issuance of dollar denominated foreign
Speaker 3: bonds in New York. So you apply it a cert
Speaker 3: tax to that to equalize the exchanger that equalize the
Speaker 3: interest rates. They eventually a voluntary credit restraint, specifically with
Speaker 3: extensions of credit abroad, so like New York banks should
Speaker 3: not loan to foreign entities. The whole point being the
Speaker 3: dollars in the US The only way that works without
Speaker 3: throwing a massive monkey wrench into the global monetary and
Speaker 3: the economic system is if there's an offshore he'd say shadow,
Speaker 3: like an equivalent or an air gap, a segregated dollar
Speaker 3: financial market that can fill the gap as New York
Speaker 3: pulls back. And so they identified pretty quickly euro dollars
Speaker 3: as the euro dollar market, meaning the eurobond market is
Speaker 3: the issuance of dollar based bonds in Europe. The euro
Speaker 3: dollar market is the issuance of dollar based liabilities. There
Speaker 3: is also a loan market, and so there's basically a
Speaker 3: mirror image financial system optimized throughout international activity that's gotten
Speaker 3: large enough to carry the load, especially with this liquidity backstop.
Speaker 3: So they see this as kind of the outlet valve
Speaker 3: for all of that activity that would otherwise drain dollars
Speaker 3: from the US. That helps them try to stabilize this outflow.
Speaker 3: So that's the sort of financial stability argument. The cost
Speaker 3: of that is like your money or your life, right,
Speaker 3: So the other version of that is losing money terry sovereignty.
Speaker 3: There's dollars that are being issued by non US entities
Speaker 3: not regulated by the Federal Reserve or the occ with
Speaker 3: only sort of intermediated access to liquidity. They don't have
Speaker 3: a direct access to the discount window. They have to
Speaker 3: go to their central bank, which goes to the VIS
Speaker 3: which goes to the Fed. So it's a coordination requirement there.
Speaker 3: And so the question is like, which of these two
Speaker 3: things is more important. In the sixties through the early seventies,
Speaker 3: the prevailing view was closing the current account deficit and
Speaker 3: not the current account deficits are the balance of payments
Speaker 3: gap and stabilizing the global monetary system was the more
Speaker 3: important thing. And so these swap line allocations keep growing.
Speaker 3: They keep growing the max size of that facility to
Speaker 3: make sure that if needed, they can stabilize the dollar
Speaker 3: and provide liquidity to the offshore dollar market.
Speaker 1: I still like the organic free range dollars analogy. So
Speaker 1: you know, you've set them out into the world, but
Speaker 1: you take a risk in doing so, Like you know,
Speaker 1: the dollars could get scooped up by a hawk or
Speaker 1: eaten by a weasel.
Speaker 3: It's like an outdoor cat.
Speaker 1: Yeah, yeah, I'm taking this too far. Okay, wait, but Josh,
Speaker 1: you mentioned the nineteen seventies, and when I think about
Speaker 1: dollars in currencies and big financial events in the nineteen seventies.
Speaker 1: I think about Nixon deepegging the dollar, and I take
Speaker 1: the point that euro dollars to some extent were solving
Speaker 1: this gold problem that you described, but that must have
Speaker 1: had some sort of impact on the market.
Speaker 3: It did, so the seventies are where this all starts
Speaker 3: to get a little more worrisome. Basically, lots of things
Speaker 3: got more worries in the seventies. Year dollars start to
Speaker 3: fall out of favor in the late sixties and early seventies,
Speaker 3: and for two reasons. One is there's these speculative attacks
Speaker 3: on various currencies that are blamed on the euro dollar
Speaker 3: market as the vehicle through which the speculative funds are
Speaker 3: flowing around. They call them hot money. So the pound
Speaker 3: crisis of nineteen sixty seven, varying crises and subsequent years
Speaker 3: are kind of blamed on the euro dollar market. That's
Speaker 3: the first thing. The second is it's growing rapidly, and
Speaker 3: that's for a couple of reasons. One is live is invented,
Speaker 3: so now you can manage the interest rate risk in
Speaker 3: a year dollar bank. So liveboard's creative for the purposes
Speaker 3: of year dollar lending, and floating rate loans, and so
Speaker 3: now you don't have this maturity mismatch that would otherwise
Speaker 3: be hard to risk manage. There's a lot of analogies
Speaker 3: to the present day.
Speaker 2: Actually, it's so funny, how like these terms that we
Speaker 2: considered to be so crude euro dollars, London interbank overnight rate,
Speaker 2: are offered rate. It's like we just we just don't
Speaker 2: even question that we have all these European names for
Speaker 2: these crucial things.
Speaker 3: Well, I should have mentioned at the beginning when we
Speaker 3: were talking about, yeah, the Soviet Union, the euro dollar
Speaker 3: does not refer to Europe, refers to the telex address
Speaker 3: of b sent So tec telex address was eurobank dash bsen.
Speaker 1: Oh it's not even this makes so much more sense now, Yeah,
Speaker 1: so year dollars meant dollars for bcent for Eurobank.
Speaker 3: That was like a like a shorthand for payment processing
Speaker 3: agents and things like that.
Speaker 2: This was a this is a totally new one.
Speaker 1: This is like a revelation because everyone thinks euro dollars
Speaker 1: have something to do with the euro or Europe, but
Speaker 1: actually 's own bank in Paris. No one thinks that. Okay,
Speaker 1: So nineteen seventies, this thing is growing, there's some concern
Speaker 1: about it potentially getting out of control. What do people
Speaker 1: do about it?
Speaker 3: So they start to call meetings and commission studies.
Speaker 1: As one does.
Speaker 3: Yeah, So, like the problem is the US is maintaining
Speaker 3: a low interest rate policy. It's attracting dollars overseas, and
Speaker 3: so the eur dollar market is absorbing outflows in the
Speaker 3: US where interest rates are low relative to euro dollar
Speaker 3: rates in European rates. And so it's a monetary policy
Speaker 3: dynamic and that's causing some consternation because at the same time,
Speaker 3: Milton Freedom it is becoming very popular, the monitorist movement
Speaker 3: is growing, and so lack of control over the money
Speaker 3: supply is much more concerning when you're focused on the
Speaker 3: money supply for monetary policy purposes. And so in nineteen
Speaker 3: seventy one, the BIS calls the Standing Committee on the
Speaker 3: Euro Currency Market.
Speaker 4: It's a very ugust sounding body.
Speaker 3: And they meet and they decide to have a standstill
Speaker 3: agreement where central banks will no longer deposit their own
Speaker 3: funds in the euro dollar mark because there was some
Speaker 3: concern that when the Bank of Italy puts dollars into
Speaker 3: the euro dollars then those get relent and redeposited and
Speaker 3: relent and redeposited, And so you have two problems associated
Speaker 3: with that. One is just multiplier effects and the other
Speaker 3: is the sort of official moniker of like, oh, central banks
Speaker 3: are using this market, that means I can use this market.
Speaker 3: And so they all agree to stop putting new money
Speaker 3: into the eurodollar market. The problem is there's not much
Speaker 3: else to do with your money, and so after three
Speaker 3: months they kind of abandon that agreement. So it literally
Speaker 3: lasts until the first renewal date and then they all
Speaker 3: kind of go their separate ways.
Speaker 1: Wait, so there's a three month standstill on the eurodollar
Speaker 1: market in the nineteen seventy.
Speaker 3: On central bank placements into the euro dollar market. So
Speaker 3: the governors of the major central banks get together the
Speaker 3: G ten, and they say, we're not going to put
Speaker 3: any more money into this market.
Speaker 2: I know, this is like one of the things every
Speaker 2: time we have these conversations. It's like nothing new under
Speaker 2: the sun. You think about some of the lessons here
Speaker 2: in terms of people are always going to chase the
Speaker 2: higher rate, So you create a new money that offers
Speaker 2: a higher rate, and the money gets sucked there. The
Speaker 2: lack of alternatives to existing market. I mean, so many
Speaker 2: conversations about alternatives to treasuries, et cetera. It's like often
Speaker 2: there's just not another thing that you can put it in.
Speaker 3: Yeah, No, I mean it's it's sort of like more
Speaker 3: money for the same perceived risk. Now that we can
Speaker 3: debate whether or not it's the same risk. But from
Speaker 3: the investor cash and vexer's perspective, I can get three
Speaker 3: percent here, five percent here and looks the same. I'll
Speaker 3: take five. Hopefully it was a little more nuanced than that.
Speaker 3: But I think that is kind of the logic. And
Speaker 3: so there's a lot of like hand ringing at the
Speaker 3: BIS in these regular meetings, at the FMC minutes Federal
Speaker 3: Open Market Committee Meeting minutes, they start getting a regular
Speaker 3: rundown of like what happened at Basil this month, And
Speaker 3: it's kind of a new development because it's no that's
Speaker 3: the point where it becomes really important. And so Governor
Speaker 3: Dane and some hit Charlie Combs or the various people
Speaker 3: who attend these meetings going back and forth to Europe
Speaker 3: in nineteen seventy one seems like a pretty like aggressive
Speaker 3: thing to do every month. But I guess the planes
Speaker 3: were nicer and they serve better meals, but they get
Speaker 3: a run down. And basically the message is we're going
Speaker 3: to commission a really like thorough study and we're really
Speaker 3: going to think about this, and we have agreed that
Speaker 3: this is an important problem that's worthy of attention, but
Speaker 3: there's very little actually done in the financial press. People
Speaker 3: kind of get to the point where they believe the
Speaker 3: screws are coming, the crew is going to get stuck
Speaker 3: in and tightened, the hammer's coming down. Like there's an
Speaker 3: article in the Economost called who killed the euro dollar Market?
Speaker 3: I think that was seventy two, So there's this sense
Speaker 3: that it's kind of like getting to the point where
Speaker 3: someone's got to do something. At some point in this process,
Speaker 3: there's a company that starts selling euro dollar branded chewing gum.
Speaker 3: So that's when you know a trend has like pressed
Speaker 3: now we pull up eBay, Oh.
Speaker 1: Yeah, I must have this chewing gum. Honestly, that's amazing.
Speaker 3: So it's kind of got like a pop thing going on,
Speaker 3: and so the view is at some point this is
Speaker 3: going to get constract contained, and by nineteen seventy three
Speaker 3: there's like a relatively broad consensus that this is sort
Speaker 3: of necessary. And then in September there's the Young k
Speaker 3: Poor War and the oil embargo.
Speaker 4: Everything changes.
Speaker 1: So this is this is our que for at two
Speaker 1: of the Josh Younger rabbit hole, or the second rabbit hole,
Speaker 1: which is petro dollars.
Speaker 3: Yeah, so petro dollars are sort of broad term for
Speaker 3: the dollar based revenue from the sale of oil. Petro
Speaker 3: dollars have been around for a while. Actually, the oil
Speaker 3: producing countries were involved in the euro dollar market since
Speaker 3: the sixties. The thing that happens in nineteen seventy three
Speaker 3: is as a consequence of US involvement or support for
Speaker 3: the Israelis in the Yunkapor War, there's an embargo of
Speaker 3: oil shipments to the US. The price quadruples, and oil
Speaker 3: revenues go from one or two percent of global GDP
Speaker 3: to five percent of GDP. So we're talking about one
Speaker 3: hundred billion dollars a year in nineteen.
Speaker 1: Seventy right, So this huge sudden influx of wealth, presumably
Speaker 1: going mostly to the oil producing nations in the Middle East.
Speaker 3: And it's kind of come from nowhere, right, It's just
Speaker 3: the price of this commodity has gone up. It's not
Speaker 3: like people issued one hundred billion new dollars with which
Speaker 3: to buy it, and so they have to figure out
Speaker 3: a way in a sense to issue one hundred billion
Speaker 3: new dollars a year to facilitate this flow. So most
Speaker 3: people are focused on the oil revenues needing a place
Speaker 3: to go, but you also need dollar loans to the
Speaker 3: oil importers to buy that oil in the first instance,
Speaker 3: So you need both sides of the equation, and the
Speaker 3: year dollar market for all the reasons we talked about
Speaker 3: was reasonably well developed at the time. So in their
Speaker 3: search for a distribution mechanism, which is again to like
Speaker 3: take the oil Saudi Arabia sells one hundred dollars worth
Speaker 3: of oil, they take those that money, they put it
Speaker 3: into something that has to somehow get to the next
Speaker 3: country that has to buy one hundred dollars worth of oil,
Speaker 3: and it goes back to Saudi and it kind of
Speaker 3: goes around in a circle. That's why it's called petro
Speaker 3: dollar recycling. And so those petro dollars need an intermediary
Speaker 3: that has elasticity. Elasticity means they can grow substantially to
Speaker 3: meet this like massive increase in demand and euro dollars,
Speaker 3: the US in particular Bill Simon, who's the Treasury secretary
Speaker 3: in nineteen seventy four for Nixon, he like is very
Speaker 3: focused on using that channel, specifically private market intermediation, not
Speaker 3: going through the IMF, not going through the BIS, but
Speaker 3: specifically private market intermediaries serving as that distribution system.
Speaker 2: So sorry, you know, because again I think, as you said,
Speaker 2: people use the word petro dollars and they sort of
Speaker 2: mean all different kinds of things, but this is bait
Speaker 2: like to use it in a way that's actually useful.
Speaker 2: What we're talking about is the system of private banks
Speaker 2: that issued dollar denominated liabilities that handled the flow of
Speaker 2: oil revenue.
Speaker 3: Yeah, and they shooed assets, right, So they had loans
Speaker 3: to oil importing countries and liabilities to deposits from oil
Speaker 3: exporting countries, and so they're the bridge because the financial
Speaker 3: system doesn't track oil imports.
Speaker 2: Who are these like there specific banks that played a
Speaker 2: prominent role or.
Speaker 3: It's just like all the usual massive banks, like they
Speaker 3: were all involved in this. There's old pamphlets. When I
Speaker 3: was JPM Warrion went down to the archives, they had
Speaker 3: these old like pamphlets like like the eur dollar market
Speaker 3: a great opportunity for this, that or the other thing,
Speaker 3: and so it's like it's just seen as like a
Speaker 3: very lucrative, very like high growth business area. The concern
Speaker 3: is that these loans are relatively long dated, and these
Speaker 3: deposits are relatively hot and flighty, and so you know,
Speaker 3: there's a lot of analogies to today. Right, So you
Speaker 3: issue a short data deposit, you're not sure how long
Speaker 3: it's going to stick around. You think it's going to
Speaker 3: stick around for a long time. But if the Saudis
Speaker 3: decide that they don't like this bank, they like that bank,
Speaker 3: they'll move their money, or they're paying incrementally higher rate
Speaker 3: or that sort of thing. So how sticky ero dollar
Speaker 3: deposits are is an open question. But the loans are
Speaker 3: long dated because countries have ongoing need to import oil.
Speaker 3: So the eur dollar market grows like exponentially, but it
Speaker 3: incurs a much larger liquidity mismatch or maturity missmat just
Speaker 3: doing more and more and more and more liquidity transformation,
Speaker 3: long term loans, short term liabilities, and there's this increasing
Speaker 3: concern by the spring of nineteen seventy four that the
Speaker 3: system is creaking under the weight of this demand and
Speaker 3: like something might break does something break.
Speaker 1: I'm going to take that. I'm going to take the bait.
Speaker 1: And also, since we're talking about you know, like historical
Speaker 1: analogies to today, I have to ask, did something break?
Speaker 3: Yes, it's something breaks, not what you'd expect. I think
Speaker 3: they're the thirty fourth largest bank in Germany. But this
Speaker 3: bankos Hrschtot, and people talk about Hrschtot risk now, but
Speaker 3: Bankoushrschtott is very involved in speculating in currencies. And I
Speaker 3: didn't talk about the Nixon shock and the deepegging of
Speaker 3: the dollar. That's a whole story in of itself. But
Speaker 3: what it does is it generates a lot of volatility
Speaker 3: in foreign exchange rates, which had previously been very sticky.
Speaker 3: And so some people see this as a risk. Some
Speaker 3: people see this as an opportunity. And Ivanhrschtott runs bankoffs Hrschtott.
Speaker 3: It's a private bank, privately owned bank, and he's like,
Speaker 3: this is my I think he called it his big hour, right,
Speaker 3: this is my moment to make my mark. They take
Speaker 3: a ass of long dollar position, goes bad and they fail,
Speaker 3: like the bank fails. Hirstott never takes responsibility for this.
Speaker 3: By the way, he writes an autobiography later called how
Speaker 3: My life Savings was Stolen for Me or My life's
Speaker 3: work was stolen for me? In Germans, I'll check with
Speaker 3: with somebody. Yeah, but but but the bank fails. It's
Speaker 3: seized by German regulators in the German afternoon, which makes sense.
Speaker 3: The problem is they had a bunch of outstanding dollar
Speaker 3: transactions in New York slated for New York afternoon. So
Speaker 3: the European transaction, the European payments go through on these.
Speaker 3: For an exchange transaction, I give you Deutsche marks, you
Speaker 3: give me dollars, right, or you give me Deutsche marks,
Speaker 3: I give you dollars in this case, and so they
Speaker 3: got their Deutsche marks, but they never sent out the dollar.
Speaker 1: So this is classic settlement risk. I mean, so Hairstott
Speaker 1: risk became basically a synonym for this type of risk.
Speaker 3: Only a synonym. It's the reason we have Basil bank
Speaker 3: regulations in the first instance. So the Basil Committee is
Speaker 3: convened to like address this issue, and it ultimately evolves
Speaker 3: into a much more elaborate international standard and standard setting mechanism.
Speaker 3: But like the idea of having international coordination of bank
Speaker 3: regulations comes out of this episode. So that's also I
Speaker 3: guess another episode, but from a we.
Speaker 1: Just need to get the Josh Younger lecture, I think.
Speaker 3: So in New York, the payments don't go through. It's
Speaker 3: a significant amount of money. There's a lot of banks
Speaker 3: holding the bag, and the payment system essentially breaks down,
Speaker 3: Like no one's willing to do cross border payments because
Speaker 3: they're not sure if this is going to happen again,
Speaker 3: Like who's next, what's the next shoe to draw? Right?
Speaker 3: Always the same, Yeah, And so the Clearinghouse Association starts
Speaker 3: allowing for clawbacks of payments until the next day afternoon
Speaker 3: to try to facilitate this, and like kind of works
Speaker 3: for the spot market, but doesn't really work for the
Speaker 3: foreign exchange derivatives market. And so you get a tiering
Speaker 3: of intermediaries of counterparties where the largest, best capitalized, most
Speaker 3: well known banks can trade freely, but the small and
Speaker 3: medium sized banks are essentially shut out of the market.
Speaker 1: Sounds a little bit familiar.
Speaker 3: So now you're eur dollar issuers can't hedge, they can't
Speaker 3: hedge their foreign exchange risks, and now they're long dollars
Speaker 3: or they're short dollars from their deposits and they don't
Speaker 3: have any hedge for the other side. So unless they
Speaker 3: have a match with the assets, which they didn't always have,
Speaker 3: they have a problem.
Speaker 2: So how did they solve this inability to hedge?
Speaker 3: It's so then the question is what do you do
Speaker 3: if there's another run, Like how do you backstop the
Speaker 3: ear dollar market in a more concrete way, who is
Speaker 3: the lender of last resort to the euro dollar market?
Speaker 2: Which is kind of like my first like the first
Speaker 2: question I had, like at the very beginning.
Speaker 3: Finally, twenty years later they start really contemplating this in detail,
Speaker 3: and because the first instance is fifty four, then in
Speaker 3: nineteen seventy four they go, you know what, we really
Speaker 3: need a plan for this, and so they start convening
Speaker 3: meetings and the usual things. In July of seventy four,
Speaker 3: there's like a tacit agreement to do something, but it's
Speaker 3: not concrete. It's unclear how it's going to be like executed.
Speaker 3: And basically the market goes do better and you have
Speaker 3: this like massive shift where on the one hand, the
Speaker 3: euro dollar market was from out of favor to very
Speaker 3: much in favor. This is an important mechanism. We need
Speaker 3: to maintain the flow of oil to facilitate economic growth.
Speaker 3: We need a stable.
Speaker 4: Urin dollar market.
Speaker 2: Oh.
Speaker 3: Interesting, the regulatory impulse reverses completely, and it's in September.
Speaker 3: The G ten central bank governors go so far as
Speaker 3: to put it a public communicate where they say we're
Speaker 3: going to do it is necessary, this is whatever it
Speaker 3: takes the first time. So this is just like what
Speaker 3: happened in Europe around the sovereign deck crisis. But it's
Speaker 3: in seventy four with relation to the euro dollar market
Speaker 3: and they say we're going to do whatever it takes.
Speaker 3: I don't remember the exact words, to facilitate liquidity in
Speaker 3: the euro dollar market and make sure it's stable.
Speaker 2: Sorry, real quick, at who said this or who is
Speaker 2: in the.
Speaker 3: G ten central bank governor to put out a communicate,
Speaker 3: So it's a collective agreement, collective They leave out some
Speaker 3: details like what do you literally mean? But because they
Speaker 3: put it in a communicay, this is all about central
Speaker 3: bank communication. Yeah, so like we're putting it on paper,
Speaker 3: we're putting it in the newspaper. They send it to
Speaker 3: the Wall Street Journal because that's what you had to
Speaker 3: do back then. Right, there's there's no computers and so
Speaker 3: like you please print this, and so they print it fat.
Speaker 1: To the Wall Street fast facts is in the seventies.
Speaker 3: Maybe it's a tele accident question. But they put out
Speaker 3: a public communication that this is the case. The goal
Speaker 3: being to like stop the contagion, so to specifically to
Speaker 3: facilitate the quid in the eur dollar market. And the
Speaker 3: implication is we need this thing to avoid a global
Speaker 3: monetary contraction. There's a lot of like handwringing in the press,
Speaker 3: like if they don't do something, we could have global
Speaker 3: monetary based destruction through the collapse of the eurillar system.
Speaker 3: That's what happened in nineteen twenty nine to nineteen thirty three.
Speaker 3: It could happen again. We're looking at another great depression.
Speaker 3: Somebody do something.
Speaker 1: So they don't announce the exact mechanism, but they just
Speaker 1: announce that they will do whatever it takes.
Speaker 3: Yeah, so very clear about their commitment in a public
Speaker 3: form as opposed to having you behind the scenes conversation
Speaker 3: that gets leaked out.
Speaker 2: Apparently the facts machine was invented in the early eighteen hundreds,
Speaker 2: but the actual modern facts in nineteen sixty four. It's
Speaker 2: just amazing. Yeah, so maybe it was a fact.
Speaker 3: I'm sure the year dollar had it. I'm not sure
Speaker 3: the central banks had it.
Speaker 2: Yet, just on petro dollars. You know, this word like
Speaker 2: even more than euro dollars, like conjures up all kinds
Speaker 2: of conspiracy theories about how we forced, you know, the
Speaker 2: force the oil exporters to use our currency. And this
Speaker 2: is really crucial, like is there an element like of
Speaker 2: truth to that story where like the US made a
Speaker 2: concerted effort to figure out how the oil exporting nations
Speaker 2: in the Middle East were going to you know, the
Speaker 2: currency that they were going to sell their oil in.
Speaker 3: Yeah, so it wasn't always petro dollars. It was originally
Speaker 3: seventy five percent dollars twenty five percent Stirling, So it
Speaker 3: was a mix. I don't know where that ratio came from,
Speaker 3: but that was sort of like the agreed upon rough
Speaker 3: breakout of oil revenues in like nineteen seventy three. And
Speaker 3: the question is like, why was it all dollars after then?
Speaker 3: And I wouldn't say conspiracy theory, but there was a
Speaker 3: policy decision at the Treasury that we do want them
Speaker 3: using dollars, and we specifically want them buying treasuries, which
Speaker 3: makes sense. So like other than the euro dollar market,
Speaker 3: you can have governments provide this redistribution mechanism as opposed
Speaker 3: to intermediating the extension of credit. It can go through
Speaker 3: government spending, and the US is looking at a widening
Speaker 3: budget deficit.
Speaker 1: Wait, so the idea there was just well, if we're
Speaker 1: going to spend enormous amounts on oil, we might as
Speaker 1: well get something back.
Speaker 3: I guess I can't validate that specifically, but like that
Speaker 3: seems plausible. All we know is that they decided that
Speaker 3: this was a good way to sell treasury bum which
Speaker 3: makes sense. There's a lot of excess dollar based savings abroad.
Speaker 3: But that requires one that the oil importing the oil
Speaker 3: exporting countries be comfortable buying treasuries, which is like, got
Speaker 3: a bunch of things around that, and two that it's
Speaker 3: stay in dollars. Those two things are connected. So in
Speaker 3: the spring of seventy four, Kissinger convenes this like council
Speaker 3: that Saudi Araba specifically to think about US Saudi economic coordination.
Speaker 3: We don't have a lot of records from that that
Speaker 3: at least I have easy access to. But David Spiro
Speaker 3: wrote a book about this a while ago, and his
Speaker 3: view was those meetings in part revolved around trying to
Speaker 3: convince them to use only dollars for their oil revenues.
Speaker 3: So like that was one line of debate at these
Speaker 3: council meetings. The other is the treasury side of it.
Speaker 3: And so Bill Simon's idea is yere dollars of the
Speaker 3: primary recycling mechanism. But like, while we're at it, maybe
Speaker 3: we'll get some revenue for the government. And so he
Speaker 3: flies to Riod in July. He actually gets scooped by
Speaker 3: Fannie May, who wants to sell more deventures to fund mortgage.
Speaker 1: Oh, they get their first and they're like and there's like.
Speaker 3: This hole back and forth in the State department about
Speaker 3: like who approved this, and like why is this guy here?
Speaker 3: First no one told me, but there's a little bit
Speaker 3: of a gold rush dynamic. But he shows up and
Speaker 3: he says, Okay, here's what we can offer. You buy
Speaker 3: treasury bonds. They will be after the auction. You can
Speaker 3: look at the price and decide if you want more.
Speaker 3: We will do him on an add on basis, which
Speaker 3: means you're not an active participant in the auction, you
Speaker 3: get like a second look and you can decide if
Speaker 3: you want them at that price. Your name will not
Speaker 3: appear on the ticket. So like the Federals are from
Speaker 3: New York, is going to be the custodian, and so
Speaker 3: they're going to transact on your behalf. You have confidentiality
Speaker 3: and the implication is in espicially saudis in July and
Speaker 3: it's like reasonably well received and they start dabbling in
Speaker 3: the treasury market in September. The problem is that the
Speaker 3: governor who did this deal dies in October rand it
Speaker 3: like suddenly he has a heart attack in DC while
Speaker 3: he's on a set of meetings, and so takes them
Speaker 3: a little while to find a successor. But the whole
Speaker 3: thing gets put on ice for a little while, and
Speaker 3: then when they find a successor, he's identified. He's not
Speaker 3: on anyone's list. There's a bunch of State Department cables
Speaker 3: for basically who is this guy, because nobody thought he
Speaker 3: would be one of them. But he's a technocrat, he
Speaker 3: was educated in the US. He's viewed as quote very
Speaker 3: pro American, was the evaluation of the State Department had
Speaker 3: and he's viewed as like the harbinger of a technocratic administration.
Speaker 3: That's going to be much more US friendly. So it's
Speaker 3: like a big signal from the Saudi government that at
Speaker 3: least taken to be that we're willing to sort of
Speaker 3: work with you guys on stuff. When he's appointed, literally
Speaker 3: his first meeting is with Treasury to restart deal negotiations
Speaker 3: on Treasury by IT purchases and that's his first meet,
Speaker 3: like three before he takes office. He goes, I want
Speaker 3: that to be my first meeting. So they have the meeting.
Speaker 3: I think it was November, and in December there's a
Speaker 3: surprise announcement from the Saudi oil cut from the Saudi
Speaker 3: oil producing companies that they will no longer except Stirling
Speaker 3: in exchange for whale so all rolaive revenue in dollars.
Speaker 3: Very awkward because the British Chancellor of the Exchequer is
Speaker 3: in Saudi Arabia, yes, leaks out. So and when esper.
Speaker 1: Conon the British had really close ties with Saudi Aramco
Speaker 1: from what I remember.
Speaker 3: Yeah, And basically the response of the administration Satura Abia
Speaker 3: is like no comment to the State Department. So they
Speaker 3: said it's very unfortunate that this happened. So I don't
Speaker 3: know what you take from that other than maybe this
Speaker 3: was like an unintended release of information. But like it
Speaker 3: happens on the thirteenth of December. On the fourteenth of
Speaker 3: December that there's an agreement on the Treasury deal. So
Speaker 3: there's a lot of alignment between these two decisions. There's
Speaker 3: no evidence that they were coordinated in any respect, but
Speaker 3: they certainly go like the same direction. And some people
Speaker 3: speculate that there was like a quid pro quo there
Speaker 3: there's no direct evidence of that in the in the record,
Speaker 3: but you know, people put two and two together.
Speaker 1: So can I just ask the Saudis agree to all
Speaker 1: of this to petro dollars sort of as a concept
Speaker 1: because they get to buy US treasuries in a semi
Speaker 1: advantaged way.
Speaker 3: It's not clear that's the only reason, but like those
Speaker 3: two things are connected in time to understand some people
Speaker 3: have put together that story. There's later comments and Treasury
Speaker 3: officials that are like the Saudis are holding the line
Speaker 3: on the dollar even though people want them to use
Speaker 3: other things, and so like that's where the records a
Speaker 3: little sketchy. But the timing and the nature of these
Speaker 3: agreements has led some people to speculate that they were connected.
Speaker 2: But also but to your point, like, if you have
Speaker 2: a surplus of dollars and that's like a problem you
Speaker 2: have to solve regardless, Right, So maybe you don't necessarily
Speaker 2: go directly to the treasury market because of some advantage,
Speaker 2: but at some level, like you got to put them somewhere,
Speaker 2: and so there was some effort made to like, here's
Speaker 2: an easy way to solve your problem.
Speaker 3: Yeah, and it's not like they're getting a better price,
Speaker 3: they're just getting somewhat better treatment in the sense that
Speaker 3: they can go through they can look at the auction
Speaker 3: decide if they like how it went, if they liked
Speaker 3: the price, they can buy them.
Speaker 4: Yeah.
Speaker 1: Imagine if SoftBank had got their first and all the
Speaker 1: Saudis would put their money in soft Bank stock. So
Speaker 1: this is it. This is the moment when pet your
Speaker 1: dollars become a thing, and euro dollars have already become
Speaker 1: a thing, and the dollar is sort of firmly embedded
Speaker 1: in the tissue of global financial markets.
Speaker 3: Yeah, and so it doesn't happen all at once, like
Speaker 3: Saudi is not all oil supply, but something like Bank
Speaker 3: eventualy put out an estimate a few years later, by
Speaker 3: seventy five, dollars are like eighty percent of oil revenue,
Speaker 3: and then by seventy six or like ninety four percent
Speaker 3: of oil revenue. So like it happens pretty quickly. But
Speaker 3: you know, at that point, the dollars is already the
Speaker 3: medium of global trade for the most part, it's already
Speaker 3: the primary reserve currency. But because oil revenues are the
Speaker 3: primary thing happening in global finance and global monetary system,
Speaker 3: like this cements in some sense that status. So all
Speaker 3: of this building up of the eurodollar market is kind
Speaker 3: of like put to work in a sense through the
Speaker 3: oil shock of nineteen seventy three in the rise of
Speaker 3: the petro dollar system. It's important to say that petro
Speaker 3: dollars don't create the ear dollar market has to be
Speaker 3: in place, elastic and flexible and already that has the
Speaker 3: network effects that allow it to function as a distribution mechanism.
Speaker 4: Right.
Speaker 2: That's the thing I like really never realized before that
Speaker 2: there's sort of like it almost sounds like petro dollars
Speaker 2: are like another skin of the eurodollar market. Then it's
Speaker 2: like a slice.
Speaker 3: Of it, Yeah, and they're the thing that makes it
Speaker 3: grow the most. But all of the basics have to
Speaker 3: be in place for that to actually work.
Speaker 1: So is the implication that, you know, we do have
Speaker 1: dollar dominance nowadays in the global financial system, but in
Speaker 1: order to get there, the US had to give up
Speaker 1: a little bit of monetary sovereignty.
Speaker 3: I think the lesson is at least just the experience
Speaker 3: of the US in that period, and the US in
Speaker 3: some sense, when dollar dominance is coming into place, you
Speaker 3: have the disruption of the Second World War, so you
Speaker 3: have a massive disruption of the global monetary system. The
Speaker 3: US is essentially the only economy left standing. And so
Speaker 3: like the fundamental arguments about global reserve currencies like very
Speaker 3: much apply to that period. Even so, there were lots
Speaker 3: of policy decisions that had to get made. This was
Speaker 3: not a foregun conclusion. There were key decision points where
Speaker 3: certain key policies were put in place, or backstops provided,
Speaker 3: or you know, agreements offered, and so like, the story
Speaker 3: of global dollar dominance like is an interesting one. I
Speaker 3: guess it's kind of the conclusion. Like, it's an interesting
Speaker 3: one with characters and actors and like decisions and near misses,
Speaker 3: and we usually think of it as just kind of
Speaker 3: like a boulder rolling down a hill and it's like
Speaker 3: kind of unstoppable, and that may yet have been so.
Speaker 3: But the real story is a very like rich one.
Speaker 2: Well as Tracy point it. You know, in the beginning,
Speaker 2: I was like a sort of emergent in Tracy's like, well,
Speaker 2: actually maybe the story is not And I think that
Speaker 2: to your point, Like, no, like things happened, meetings happened,
Speaker 2: flights happened, troops to Europe happened, like all these things.
Speaker 3: Yeah, Like I don't think if there's a movie in it,
Speaker 3: but like there's a book in it, you know, that
Speaker 3: kind of thing.
Speaker 1: Someone makes euro dollar gum, there's a TV series, there's
Speaker 1: a TV series for sure. Well, Josh, we're gonna have
Speaker 1: to leave it there. But it was wonderful having you
Speaker 1: on the show. And you know, as much as some
Speaker 1: of the dedollarization discourse annoys me, I'm very grateful that
Speaker 1: it gives us a chance to revisit financial history with you.
Speaker 1: So thank you so much.
Speaker 4: No, it's great to be back. Thanks for having me.
Speaker 1: So, Joe. I don't know if anyone listening heard me
Speaker 1: frantically typing at the euro dollar gum mentioned, but I haven't.
Speaker 2: We both pulled up emay and stuff like I need
Speaker 2: to find this.
Speaker 1: I haven't been able to find an image, but there's
Speaker 1: a nineteen seventy four article from the New York Times.
Speaker 1: The headline is the euro dollar bubble, and it has
Speaker 1: a description where it talks about the inflow of euro
Speaker 1: dollars takes the form of bubble gum package in gold
Speaker 1: foil to resemble coins.
Speaker 2: We gotta find that gum.
Speaker 1: Isn't that amazing? There's so much pick out of there,
Speaker 1: like so many things I hadn't realized, including where the
Speaker 1: euro in euro dollar actually came from. But I guess
Speaker 1: two things stand out so one the theme that Josh
Speaker 1: hit on at the very end, this idea that we
Speaker 1: think of the dollar dominance theme as largely a sort
Speaker 1: of network organic effect that emerged over time, when actually, yes,
Speaker 1: there were some conscious decisions that might have gone into
Speaker 1: at least making it more probable. And then secondly, the
Speaker 1: asset liability point. That's something that Karthik mentioned in his
Speaker 1: episode as well, where he was talking about like, well,
Speaker 1: you're not going to get a lot of un Chinese
Speaker 1: renman b dominance until you actually see liabilities denominated in
Speaker 1: this and that's kind of what happened with euro dollars, right.
Speaker 2: Yeah, no, so much I learned from that, and you know,
Speaker 2: to the point not to make everything like what does
Speaker 2: it mean for today? But then it sort of gives
Speaker 2: you a further appreciation of how much work another currency
Speaker 2: would have to do to ever even like entertain the
Speaker 2: idea of like a replacement for this, like not just
Speaker 2: it's not just going to be emergent. It's going to
Speaker 2: be the result of diplomacy and back and forth and
Speaker 2: all these other things. You know, I was thinking about.
Speaker 2: We recently recorded an episode with Jim Grant and he
Speaker 2: made that point. He's like, you know, in technology, they
Speaker 2: sort of like build on the shoulders of giants. In finance,
Speaker 2: you just sort of repeat the same stories over and
Speaker 2: over again.
Speaker 1: And do you build on the communicats of Basil?
Speaker 2: Yeah, and you just sort of do it and again.
Speaker 2: It's like every time we talk to Josh, it's like, man,
Speaker 2: nothing really changes. Just the risk is slightly different. There's
Speaker 2: a new name for it, but it's the same sort
Speaker 2: of puzzles in different time periods.
Speaker 1: Yeah, no new risk under the sun. Well, on that note,
Speaker 1: shall we leave it there.
Speaker 2: Let's leave it there.
Speaker 1: This has been another episode of the Audlots podcast. I'm
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy
Speaker 1: Alloway and.
Speaker 2: I'm Joe Wisenthal. You can follow me on Twitter at
Speaker 2: the Stalwart. Follow our producers on Twitter Carmen Rodriguez at
Speaker 2: Carman Arman and Dashel Bennett at dashbot. And check out
Speaker 2: all of the Bloomberg podcasts under the handle at podcasts
Speaker 2: and for more oddlogs content, go to Bloomberg dot com
Speaker 2: slash odd lots, where we have transcripts a blog newsletter
Speaker 2: comes out of your Friday. And check out the discord
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Speaker 2: four to seven discord dot gg slash odd lives really
Speaker 2: fun place to go.
Speaker 3: There a lot.
Speaker 2: Thanks for listening.